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32 of 35 people found the following review helpful
on November 27, 2012
Gorton makes four very important points:

(1) Financial crises always arise when the public (individuals or businesses) lose faith in bank debt. According to Gorton, creating debt is the main business of banls. It is this debt that enables our economy to function. Unfortunately, in times of rapid expansion, banks create debt too quickly and so become fragile.

(2) Financial crises are always characterized by bank runs. These can be very visible, e.g. depositors lining up to get their money back. Or they can be invisible, e.g. lenders in the shadow banking system, who typically lend for a day or so at a time, refusing to roll over the loans to suspect banks. It follows that the real problem is not banks that are under-capitalized, but banks that are illiquid, i.e. they don't have enough cash on hand to meet demands. (They could have lots of illiquid assets, but so what?)

(3) The banking sector is so essential to the economy that governments will not let it go under. In this sense, banks have been "too big to fail" for at least two centuries. The tool used by the government evolves over time -- suspensions of withdrawals and "bank holidays" in the nineteenth and early twentieth centuries, the Fed as lender of last resort and deposit insurance in the twentieth century, bailouts via purchase of toxic assets in the twenty-first. Each time the popular reaction is fury: Populists wanted to hang the bankers a hundred and fifty years ago, a hundred years ago, etc.

(4) Both fortunately and unfortunately, financial innovations allow banks to create new forms of bank debt to satisfy the growing demand for such debt. Asset-backed securities and CDOs are just the latest in a long line, e.g. checking accounts, credit cards, and so on. Government is usually one or two steps behind. Indeed, with the disappearance of the physical queue of depositors clamoring to be paid, the government now has difficulty recognizing when a bank run occurs, and tends to intervene too late.

Gorton's solution is more regulation. That may be controversial, but Gorton's case is very well argued. He examines in detail financial crises over the past two hundred years (although he limits himself almost exclusively to the U.S.). The lessons he draws lead him to the above conclusions, plus a number of other insights.

Unfortunately, as with his previous book, Slapped by the Invisible Hand, this book is very badly written and could use a strong editor or even a rewrite. It is repetitious in many places, the author jumps around a bit, and may sentences are just plain awkward. When he quotes at length a nineteenth-century author, that comes as a relief. For this reason, I'm giving it four stars instead of the five that the content richly deserves.
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15 of 17 people found the following review helpful
VINE VOICEon November 2, 2012
If there's a conventional wisdom about how to respond to the financial crisis, it's that banks need higher capital requirements. President Obama, in his first presidential debate with Mitt Romney, said the Obama administration had said, "banks, you've got to raise your capital requirements." Mr. Romney agreed: "you need to have leverage limits." The free-market-oriented Wall Street Journal editorial page editorializes in favor of tougher capital requirements as a "critical reform," while the left-of-center New York Times editorial page mentions the Dodd-Frank Law imposing "higher capital requirements for banks" as a reason to vote for Mr. Obama.

For that reason alone, Gary Gorton's new book is worth a look. Mr. Gorton, a professor at Yale and a former consultant to AIG Financial Products, challenges that conventional wisdom on capital requirements. "Crises are about cash and not capital," he writes. "High capital ratios cannot prevent runs." In case that is insufficiently clear, Mr. Gorton goes on, "There is almost no evidence that links capital to bank failures."

Mr. Gorton brings to bear a historical perspective along with his refreshing willingness to challenge the conventional wisdom. He says the lack of such a historical perspective is one reason that the economics profession failed to see the crisis coming: "It used to be that economics PhD programs required at least one term of economic history, but this has disappeared. Many top economics programs that previously had two or three economic historians now have none."

Among the episodes that Mr. Gorton recovers from the past are the 1857 case Livingston v. Bank of New York, in which a New York court found "the mere fact of suspension of specie payments" was not sufficient to force a bank into liquidation. Another is the 1934 case Home Building & Loan Association v. Blaisdell, in which the Supreme Court upheld the Depression-era Minnesota Mortgage Moratorium Act.

The author also has an eye for illuminating quotes when it comes to more recent events. He reminds readers that White House economic adviser Austan Goolsbee said of AIG executives, "It's almost like these guys should have gotten the Nobel Prize for evil." And that Charles Grassley, a Republican senator, suggested that AIG executives resign or commit suicide.

Given that level of hostility from government officials, it is somewhat surprising that Mr. Gorton concludes by recommending regulatory changes that "would place the government in an oversight role in the securitization and repo markets." Which government overseer would Mr. Gorton like for those markets, one wonders? Senator Grassley, or Professor Goolsbee?

The answer to that question aside, this slim and lively volume makes a useful addition to the vast library of books about the financial crisis. I learned from and enjoyed this one even though I have already read many of the others.
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12 of 14 people found the following review helpful
on December 20, 2012
This is a highly informative analysis of American financial crises and bank runs since the 18th Century. Gorton's historical perspective, as opposed to the purely journalistic approach of most "insider" books--though he too was an insider at AIG--allows him to describe the 2007 crisis as the latest in a long series of sudden losses of public confidence in financial institutions. Gorton explains why it is hard to prevent such crises without absolutely foolproof government insurance ("bailouts") against every loss of every type on Main Street and Wall Street, a backup that is almost impossible to arrange because the government's own solvency isn't absolute. Nor is anyone else's in a money-based economy. There was no bank run in 2007 (the runs were on the investment houses) because we trust the FDIC to keep our bank deposits fully safe. I'll let you follow the details of this argument yourself, but I guarantee you will learn something.

I deduct one star because of the writing. For one thing, like most contemporary books--all of these comments apply to most contemporary books--this one seems not to have been professionally copy-edited. Sometimes it reads like a first draft. I don't mean Gorton is a bad writer. Even the most famous and skillful writers (including Shakespeare, Balzac, Dickens, Tolstoy, Stephen King, etc.) are not competent to edit their own manuscripts. Maybe there are no professional editors any more. Maybe publishers don't care to pay for them. In Gorton's case, thorough editing would have eliminated not only the misused words and confusing sentences but more importantly some of the wordiness and repetition. Again like many current books this one is probably half again as long as it needs to be to make its case. Often it seems that each sentence or even paragraph is totally unaware that other sentences or paragraphs in the book exist and have already used a certain fact or made a similar point (like the causes of bank runs). Modern non-fiction in particular often seems to lack a sense of overall organization. Like a dumbed-down documentary on the History Channel where the story begins all over again after every commercial, it's Back to Basics in every chapter.

Still, four out of five ain't bad. If you are interested in economic ideas and the real roots of the Great Recession, Gorton's book will amply reward your patience.
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26 of 33 people found the following review helpful
on November 4, 2012
Good historical perspective although almost entirely limited to the US economy and financial system. The author does a good job explaining the origins and evolution of bank notes as currency both before and after the Civil War.

As it moves into the 2008 GFC, the book describes the impprtant role of the 'repo' market and the shadow banking system. The author explains that this crisis was a run on the bank. But in this instance it was a run on banks by banks, not by individual depositors.

The moral of his story is that, since the Great Depression, financial institutions have had, do have and always must have explicit (deposit insurance) and implicit (too big to fail) backing from taxpayers.

I therefore don't understand (and the book does not explain) why bank shareholders and management get the upside while taxpayers wear the downside. If credit is a necessary public good, then why isn't it treated more like a utility---either taxpayer owned or much more highly regulated, with limited upside and limited downside?
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7 of 8 people found the following review helpful
on December 12, 2012
This could have been a terrific book. What it needs is the firm hand of a good editor. Unfortunately, the first half of it reads like a collection of lecture notes loosely stitched together. Sadly, the main points are repeated over and over, and the flow of the text is interrupted with extremely lengthy quotes that often add rather little to the point being made. Many should have been footnotes, rather than part of the text.

I initially found the book difficult to read, not because of the content, but because of the poor writing style and organization. Fortunately, as the author nears the end of the book both style and organization improve markedly

That aside, what the author has to say is very important, highly relevant to understanding the financial crisis, and highly pertinent to rethinking the central questions that economics should be tackling. Sadly, too many academic economics are more concerning with impressing their academic colleagues with their mathematical prowess, displayed in papers and books that address theoretical questions with little practical relevance, but that are highly publishable, especially when reviewed by disciplinary colleagues with the same proclivities.

So I give the book three stars for style, and 5 for content. Average: four stars.

I'm usually not so critical, but the author missed a real opportunity for excellence. Here's my advice: read the first half rapidly, so as not to get bogged down, and be sure to get to the end. It is worth it.
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2 of 2 people found the following review helpful
on September 26, 2013
This book is a masterpiece in placing the Global Financial Crisis in the context of previous crises and explaining how the crisis came about and, most importantly, why economists and policy analysts failed to predict it. Very compelling. On the downside, the build up to the final most interesting chapters takes a lot of perseverance to work through the detailed explanations of previous banking crises, with quite a lot of apparent repetition. Extremely well worth reading to fully understand why almost everyone failed to predict or even understand that the crisis could happen in the modern U.S. economy
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3 of 4 people found the following review helpful
on May 2, 2013
One weakness of books about the recent financial crisis, even the very good ones, is the tendency to fall back on categorical statements as explanations. Rather than focusing on characteristics of derivatives that allow for massive instability, some writers will simply refer to derivatives, thereby ensuring that naive readers worry about the boogeymen of the last crisis. Gorton takes a step back to look at the financial crisis in relation to financial crises from the last two centuries of American finance. In the process, he avoids the temptation to rely on categories of instruments, and looks at effective weaknesses (the hapless search for private market "risk-free" instruments, the approach of governments to "systematic" financial problems...) across monetary and banking regimes. As Gorton presents it, the story of free banking inspired state banking isn't complete without appreciating how and why it became national banking. The system morphs because the system chooses to avoid the consequences of its earlier principles. Gorton's overarching thesis is that the morphing is not random in intent. I felt that Gorton avoided being shallowly prescriptive. Even if you disagree, there is still plenty of great analysis. This is ultimately a very practical look at history.
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on April 6, 2015
Interesting points made in the book. Everyone wshould read this book.
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2 of 4 people found the following review helpful
on February 13, 2013
In many ways an excellent book: historical perspective, indispensable to the subject, mastery of the intricacies of the shadow banking system, consequences of banking runs.
Disappointing in some ways: banks are described as creating their own money (they do), but the need for funding, the amount of funding and the funding risk are never clearly described, so it is difficult to see the difference between the author's treatment of banks and the conventional textbook one. I think the author knows much more than he shows in the book.
Very good general reading, very readable, complete overview rather than just stories. The first of a second generation of books on the 2007 crisis?
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3 of 6 people found the following review helpful
on January 24, 2014
Written from a very academic point of view. Could have been Gorton's notes for lectures. Lots of old quotes about 100 year old financial crises; not much about last one.
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